Intel inside

The government’s decision not to grant more concessions asked for by chip maker Intel to set up a unit in the country—Intel wanted a host of tax waivers and an upfront payment of $100 million in return for investing $700 million—is the right one, for there is a host of evidence to show that foreign investment comes into a country even without fiscal and other incentives provided the domestic market is large enough, or there is an abundant supply of qualified workers, or other attributes like these.

To the extent fiscal sweeteners are required, it is to offset disadvantages like a small domestic market or poor-quality infrastructure—in which case, a country is better-off spending funds that would have been expended on incentives to develop better infrastructure.

To cite the most obvious example, a few years ago, when the domestic market was minuscule, hundreds of millions of dollars would have been required to induce someone to set up a mobile phone-manufacturing unit in the country; today, with demand galloping, firms like Nokia and LG are planning to set up units here.

While giving fiscal incentives to attract investment always looks attractive, particularly when you see how other countries have offered similar tax sops and built up a lucrative industrial base around these, there are enough studies that show this is a race to the bottom.

Besides, if the environment is not conducive to setting up industries (and India’s is not, as can be seen by the time it takes to set up and close units), there is no guarantee that getting in one Intel will set off a wave of investment activity around it.

When McKinsey interviewed Ford officials (Ford was given generous incentives to set up shop in Tamil Nadu), they said the three top factors in their decision were the availability of a supplier base and skilled labour as well as the quality of infrastructure. Indeed, in the case of Brazil, which provided even more generous incentives to auto firms, McKinsey’s analysis suggests foreign carmakers set up 40 per cent more capacity than that which would have been set up otherwise during the late 1990s—but by 2002, the industry had 80 per cent overcapacity and this lowered everyone’s productivity.

Recent work from research body Indian Council for Research on International Economic Relations (Icrier) yields similar results—indeed, there is a body of global academic work that shows incentives are generally ineffective once the role of fundamental determinants of foreign investment is taken into account.

Icrier used data for 15 developing countries in south, east and south east Asia for the period 1980-81 to 1999-00 and ran various regressions to estimate the impact of variables like domestic tax policy, fiscal incentives, the size of the domestic market, and so on. Not surprisingly, it found the size of the domestic market was an important factor in determining whether a foreign firm would invest in the country.

So was the level of education of the work force and its size, while the availability of electricity from the grid was also an important factor determining whether firms invested in a country.

Equally obviously, a high degree of restrictions on foreign investors (you can’t invest here, you must have a local partner, etc.) tended to be an important reason for investment staying away.

Incentives, the analyses showed, hardly made any difference—the study showed, however, that incentives matter more for investment from developing countries than they do for investments from developed countries. India needs to work on getting its business environment more friendly, not giving more incentives